We have added a new valuation metric to our model, namely the Total U.S. Market Capitalization to GNP ratio. Total U.S. Market Capitalization accounts for the market cap of the NYSE going back to 1929, as well as the Nasdaq and Amex from their respective inception dates. This measures the size of the stock markets relative to the size of the total U.S. economy, including foreign production.
- To discover which measures of stock valuations carry meaningful information about future returns.
- To create a multi-factor model using the best indicators to forecast future stock market returns over horizons from 5 to 30 years.
There are several reasons why it may be useful to have a more robust estimate of future expected returns on stocks:
- People who are approaching retirement need to estimate probable returns in order to budget how much they need to save.
- A retiree’s level of sustainable income is largely dictated by expected returns over the early years of retirement.
- Investors of all types must make an informed decision about how best to allocate their capital among various investment opportunities
Many studies have attempted to quantify the relationship between Shiller PE and future stock returns. Shiller PE smoothes away the spikes and troughs in corporate earnings which occur as a result of the business cycle by averaging inflation-adjusted earnings over rolling historical 10-year windows.

Source: Vitaly Katsenelson (2011)
Modeling Across Many Horizons

Source: Shiller (2011), DShort.com (2011), Chris Turner (2011), World Exchange Forum (2011), Federal Reserve (2011), Butler|Philbrick & Associates (2011)
Process
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Source: Shiller (2011), Doug Short (2011), Butler|Philbrick & Associates (2011)
Forecasting Expected Returns
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Source: Shiller (2011), Doug Short (2011), Butler|Philbrick & Associates (2011)
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Source: Shiller (2011), Doug Short (2011), Butler|Philbrick & Associates (2011)
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Source: Shiller (2011), Doug Short (2011), Butler|Philbrick & Associates (2011)
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Source: Shiller (2011), Doug Short (2011), Butler|Philbrick & Associates (2011)
Putting the Predictions to the Test

Source: Shiller (2011), Doug Short (2011), Butler|Philbrick & Associates (2011)